Tax warning on overseas income

Do you earn
income overseas? A recent case highlights why you might pay more tax than you
thought on foreign income.

If you are
an Australian resident and earn income from overseas, such as income from
investments, sale of assets such as property, distributions from foreign
trusts, etc., you will generally need to declare that income in your Australian
tax return. If you have paid tax in a foreign country on that income, you might
be able to claim a foreign tax offset to reduce your Australian tax liability.

Sounds
simple enough but a recent case highlights where problems can occur and you
might end up paying a lot more tax than you thought.

The
taxpayer in this case was a resident of Australia but was taxed in the US on
gains they made on interests in US real estate. Most of the gains they made
were taxed at a concessional rate of 15% (rather than the normal rate of 35%)
because the interests had been held for more than one year. Some of the gains
were ultimately taxed at 35% in the US.

The capital
gains were also taxed in Australia and qualified for the general CGT discount
of 50%.

As the
taxpayer was a resident of Australia and had paid tax on the US gains, the
taxpayer claimed a foreign income tax offset for all of the US tax they paid.
However, the ATO amended the tax assessment and only allowed a tax offset for
slightly less than 50% of the tax they paid in the US.

The problem
for the taxpayer was that while the US and Australia both have tax concessions
for longer term capital gains, they operate quite differently. The US applies a
lower rate to the whole gain while Australia applies a normal tax rate to half
of the gain. Unfortunately for the taxpayer, the Federal Court held that the
Commissioner’s approach was correct. If foreign tax has been paid on an amount
that is not included in your assessable income then you cannot claim a foreign
tax offset on it. In this case, the portion of the capital gain that was exempt
from Australian tax because of the CGT discount, was not included in assessable
income.

It is not uncommon for people who have made capital gains on foreign assets to assume that they get all of the tax back that they paid overseas. Unfortunately, that’s not necessarily the case and often only a partial credit is available, if at all.